Weak U.S. legal oversight puts burden on compliance pros to protect their firms, author says

September 4, 2012

By Stuart Gittleman

NEW YORK, Sept. 4 (Thomson Reuters Accelus) – An inadequate government and industry response to the financial crisis will require compliance professionals to do more to protect their firms, customers and colleagues, Jeff Connaughton, who said he saw firsthand how reform withered in Congress, has told Compliance Complete.

“Until law enforcement causes actual deterrence, compliance needs to understand what institutional and retail customers can – and can’t – stomach. And those customers need to get back to performing exacting due diligence. Until we have tough law enforcement again, institutional customers will have a greater impact on Wall Street behavior than federal prosecutors,” said Connaughton, a former investment banker, aide in President Bill Clinton’s administration, lobbyist and longtime political associate of Vice President Joe Biden.

After serving as Delaware Democratic Senator Ted Kaufman’s chief of staff during the first two years of President Barack Obama’s response to the credit and housing crises and the debates over the Dodd-Frank Act, Connaughton described what he saw in a book, The Payoff: why Wall Street always wins, that is being published today.

When Obama and Joe Biden took office in January 2009 and longtime Biden aide Kaufman was appointed to serve until the next election in November 2010, Kaufman asked Connaughton to help him oversee the response to the financial crisis and the planning to prevent future crises.

Kaufman, who did not intend to seek election on his own, said he would not accept campaign donations, but he could not loosen the financial industry’s grip on legislation and regulation, or overcome government inertia and unwillingness to properly fund law enforcement, Connaughton said.

One notable failure he cited was that Congress voted to authorize spending $165 million on crisis-related criminal probes, but when it came time to actually appropriate the money, only allocated $30 million for the job. This is one reason why the enforcement response to the 2008 crisis was so much less effective than the response to the smaller, less damaging savings and loan scandal of the late 1980s, Connaughton said.

Given the current state of financial reform, and its prospects no matter what happens on Election Day, Connaughton suggested five ways to restore investor confidence in market integrity:

  1. Reform of Wall Street and Washington require nonpartisan recognition of the need to restore long-term financial stability and credible capital markets, and to reverse an economic decline in which the best and brightest create and build financial ploys instead of new industries and better products.”MIT needs to be sending its graduate engineers to innovate our economy, not to find new ways to skim Wall Street profits,” Connaughton said.Reform will require ending crony capitalism, restructuring finance either by reinstating Glass-Steagall or by placing size-and-leverage limits on too-big-to-fail institutions, holding accountable those responsible for fraud, and being able to monitor complex trading venues and high-frequency strategies.

    “We’ll have none of those things until we break Wall Street’s hold on Washington,” Connaughton said.

  2. This hold will continue until voters force presidential and congressional candidates to take a stand on reform and to stand by it, and until elected officials force regulators to either prove there is no double standard for the financial industry or that the industry’s health is more important than legal accountability.Voters must demand a well-organized, well-resourced and determined effort to hold Wall Street crooks to account, and investors must participate more in rulemaking to counter the outsized impact of the financial industry in the regulatory process, he said.
  3. Breaking this hold requires reducing the impact of money in politics, and keeping the process as far away as possible from what Connaughton calls “The Blob” – ex-lawmakers and officials, lobbyists, fundraisers, lawyers, analysts and public-relations professionals.Voters should demand that candidates agree not to take campaign contributions from too-big-to-fail banks and nonbanks, and support fees on Wall Street trades to pay for better oversight such as a consolidated audit trail and stronger regulatory and law enforcement.
  4. Federal agencies should recruit the best candidates, train them better, pay them more and subject them to a one-year post-employment cooling off period during which they can’t earn money in a way that’s directly related to their former job.
  5. The next financial crisis is baked into Dodd-Frank and its implementation, and will give the reform movement an opportunity to clean house and break the axis of greed and regulatory capture.

Why compliance needs to do more

Hearings leading up to the passage of Dodd-Frank suggested that some agencies were “captured” by the industries they were supposed to oversee; they considered the industries their “clients” and competed with other agencies for user fees by offering a “light touch,” Connaughton said.

An unwritten code of silence had a chilling effect on individuals who wanted to do more. Many top officials who came from the industry because of the perceived need for experience in rulemaking and enforcement helped dampen aggressive regulatory efforts, he said.

Despite years of helping Biden focus on foreign affairs, Kaufman got up to speed quickly in the Senate, Connaughton said. Financial industry oversight is “not rocket science and it doesn’t take years to learn … [regulators] need objective detachment more than they need recent industry experience,” he said.

For example, Connaughton said, the Securities and Exchange Commission “is a regulator by consensus,” despite the fact that “industry people will always complain about the cost of prospective rules.”

“Rulemaking too often involves picking the lowest hanging fruit. The biggest players on Wall Street essentially grant their permission to the SEC to go after a few sacrificial lambs to create the illusion of reform,” Connaughton said.

As for Dodd-Frank rules, “I would trade sheaves of [them] for some plain old law enforcement of the provisions in Sarbanes-Oxley,” Connaughton noted.

Compliance professionals “face a real challenge at being internally effective until people start going to jail for breaking the law. We have defined deviancy down. Instead of doing what is strictly legal, too often accountants and lawyers consider what others are doing and getting away with,” Connaughton said.

The financial services industry must itself undergo a cultural change if it is to survive and thrive, Connaughton added, saying it “needs to get back to the credo of long-term greed … the markets are losing customers who may not come back. Even a few bad apples who go unpunished can make Main Street think the whole Wall Street barrel is rotten.”

Whatever our current response, Connaughton said, it “is too late for this financial crisis … the statutes of limitation have run. We need a cultural change to prevent the next one.”

In addition, Connaughton said, “We need end-of-career regulators who feel immune to Wall Street power, who can’t be touched.”

But reform is not a hopeless cause, especially if it’s incremental, Connaughton said. For example, the SEC and other regulators are trying to better monitor markets and trading strategies by reviewing the vast quantities of data broker-dealers are already required to collect.

The SEC has long had the authority to obtain this information, and former SEC Chairman Harvey Pitt has suggested disseminating it to the public more widely. The SEC should also ask academics what else they need.

In addition to making for better-informed rulemaking, better analysis will also help the SEC face court challenges based on purportedly faulty economic underpinnings of its regulatory processes, Connaughton said.

(This article was produced by the Compliance Complete service of Thomson Reuters Accelus. <a href=”http://accelus.thomsonreuters.com/solut ions/regulatory-intelligence/compliance- complete/” target=_new”>Compliance Complete</a> provides a single source for regulatory news, analysis, rules and developments, with global coverage of more than 230 regulators and exchanges.)

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